In this episode of Let’s Talk Legal, attorneys Cecil Harvell and Wes Collins discuss the importance of buy-sell agreements for businesses with multiple owners. From unexpected death or disability to bankruptcy, divorce, or disagreements between business partners, these agreements help establish how ownership interests will be handled when circumstances change. The discussion highlights how proper planning can protect both the business and its owners while helping prevent costly disputes and litigation.

What is a buy-sell agreement?

A buy-sell agreement is a written contract between business owners that establishes what happens to an ownership interest when certain events occur.

These agreements may also be called shareholder agreements or membership agreements, depending on the business structure. They can apply to corporations, limited liability companies (LLCs), family businesses, and other jointly owned enterprises.

The purpose is to establish clear expectations before a problem arises, protecting the interests of the business, its remaining owners, and the owner who may need to leave.

Planning for life's unexpected changes

Business ownership can be affected by circumstances that no one anticipates when a company is formed.

An owner may become disabled, develop a serious illness, pass away, experience financial difficulties, or simply decide to leave the business. Disagreements between partners may also make continued ownership impractical.

A properly drafted buy-sell agreement establishes how these situations will be handled, including when an ownership interest may be purchased, how its value will be determined, and how the departing owner or their estate will be compensated.

When business partners disagree

One particularly difficult situation occurs when an owner stops contributing to the business but continues to benefit financially from its success.

Wes explained that terminating someone's employment does not automatically eliminate their ownership interest. Even if a shareholder is no longer working for the company, they may still own their shares and remain entitled to the benefits associated with that ownership.

Without an agreement establishing a buyout mechanism, the remaining owners may find themselves negotiating with someone who refuses to sell or demands substantially more than their interest is worth.

These situations can lead to prolonged disputes and expensive litigation.

Why the best time to plan is before trouble begins

Cecil and Wes emphasized that the ideal time to establish a buy-sell agreement is when the business is formed and the owners are working together successfully.

When relationships are strong, owners can negotiate terms fairly without the pressure of an existing dispute.

However, businesses that did not establish an agreement when they were formed can still put one in place later. The important consideration is to address these issues before a conflict, ownership transition, or unexpected event makes negotiations more difficult.

Protecting family-owned businesses

Buy-sell agreements are particularly important for businesses owned by spouses, siblings, parents, children, or other relatives.

Family businesses may pass through multiple generations, creating increasingly complicated ownership arrangements as additional family members become involved.

An agreement can establish what happens when a family member dies, becomes disabled, withdraws from the business, or wishes to transfer their ownership interest.

Clear contractual provisions can help prevent business disagreements from becoming family disputes.

Determining the value of an ownership interest

One of the most important provisions in a buy-sell agreement is the method used to determine what an owner's interest is worth.

The owners may agree in advance on a specific value, establish a valuation formula, or require an independent business appraisal when a triggering event occurs.

Business valuations can be significantly more complicated than real estate appraisals because they may require analysis of cash flow, financial statements, liabilities, profitability, and other characteristics unique to the company.

Cecil explained that professional business valuations can also be expensive, making it especially important to agree beforehand on how the valuation process will work and how disagreements will be resolved.

Funding the buyout

Determining the value of an ownership interest is only part of the process. The agreement must also explain how the purchase will be funded.

Will the remaining owners pay immediately? Will the company purchase the interest? Can payments be made over time?

Cecil discussed the use of life insurance as one potential funding mechanism when an owner dies. Properly structured insurance arrangements can provide funds to compensate the deceased owner's estate while allowing the business to continue operating.

Other payment arrangements may include installment payments or continued compensation over an agreed period.

The important consideration is making sure the financial terms are realistic and can actually be carried out.

Divorce, bankruptcy, and other triggering events

A buy-sell agreement may identify certain circumstances as triggering events that activate a contractual buyout process.

These can include divorce, bankruptcy, disability, death, or other changes affecting an owner's ability to remain involved in the business.

For example, an agreement may provide a mechanism to purchase an owner's interest when personal financial problems or divorce proceedings threaten to complicate the company's operations.

Wes explained that these provisions are intended to protect the business and its remaining owners while providing an organized and fair process for compensating the departing owner.

Reviewing and updating the agreement

Like other important legal documents, buy-sell agreements should be reviewed periodically.

Wes suggested approximately five years as a general benchmark, with additional reviews whenever significant changes occur.

Those changes might include a new owner joining the business, an existing owner selling shares, a family member becoming involved, or substantial changes in the company's financial position.

A well-drafted agreement should also address how future owners become bound by its terms and whether existing owners must approve ownership transfers.

Keeping the agreement current helps ensure that it continues to reflect the business's structure, value, and ownership arrangements.

The risks of incomplete business documents

Forming an LLC or corporation online may be relatively inexpensive, but basic formation documents do not necessarily include the provisions needed to protect business owners when disputes arise.

Wes described litigation involving missing or poorly drafted shareholder agreements that resulted in legal expenses reaching tens or even hundreds of thousands of dollars.

The attorneys emphasized that properly drafted agreements should address not only what happens when an owner leaves, but also the practical details of valuation, payment, funding, and implementation.

Bottom line

A buy-sell agreement is an important planning tool for businesses with multiple owners, including closely held and family-owned businesses.

By addressing unexpected events, ownership transfers, valuation methods, payment terms, and potential disputes before they occur, business owners can create a more predictable path forward.

As Cecil Harvell and Wes Collins emphasized, the best time to establish these protections is when everyone is getting along, rather than after a disagreement or unexpected event has already created a problem.